Getting into the financial market can be daunting to the point that only 2% of Indians invest in the stock market in the first place. Some might argue that this is caused by the high barrier of entry posed by the investment sector, however this used to be the case before the rise of easy to use online discount brokers such as PayTm Money and Zerodha.
The problem thus exists with the general ignorance around the various terminologies which are fundamental to the financial market in general. Here I have compiled a list of five very commonly discussed financial instruments. But what are financial instruments? Simply, these are assets which can be traded on the open market. It can also be contrived as packages of capital which may be traded on the financial market. These assets are not always cash, they can also be a contractual right to deliver or receive cash, evidence/title of ownership.
Financial instruments are thus documented legal agreements involving any monetary value. This could be an equity based financial instruments representing the ownership of an asset whereas debt-based financial instruments representing the loan made by an investor to the owner of the asset.
Thus, with a clearer understanding of what financial instruments are, lets look at some of the most common financial instruments on the market-
Equities
Modern corporations are structured in a way where authority and financial expectations are predetermined via the amount of shares or equity one holds in that company. Therefore, Equity is typically referred to as shareholder’s equity in publicly listed companies to represent the amount of money that would be returned to the company’s shareholders if all of the assets were liquidated and the company’s debt fully paid off in the case of said liquidation.
Shareholder’s equity can also be an important indicator of the company’s book value as it represents the pro-rata ownership of the company. As an investor when you look to invest in a company on the public market, it is of primary importance to know the proportion of ownership entitled by a single stock. Owing stock in such a company also gives you the potential for capital gains and dividends.
As a shareholder, your equity can either be positive or negative. Basically, a positive shareholder equity signifies that the company has enough assets to cover its ongoing liabilities, similiarly, a negative shareholder’s liability the company’s liabilities exceeds its assets.
Stock Indices
If you are in the stock market to invest long term, this might be the best option you have. Stock indices essentially highlights the performance of a wider stock market view or portion. Usually divided by their market cap, stock indices are the financial instruments listing a group company’s shares. This is a very important indicator when it comes to understanding the overall market situation from an economical point of view.
We have all heard of terms like Sensex and Nifty, those are essentially stock indices representing stocks selected stocks listed in the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). One of the strongest suits of stock indices is the high diversification such an option provides.
For instances one of the most popular stock indices in India is NSE’s NIFTY50 which is a diversified index composed of stocks from top 50 publicly listed Indian companies from across 14 sectors.
This pictoral representation depicts the weightage of companies listed on National Stock Exchange. This gives us a clearer idea of the diversification such index options provide. Similiar options include the Sensex, America’s Dow Jones Industrial Average, Germany’s DAX, Japanese NIKKEI, British FTSE100 to name a few.
Commodities
A rudimentary understanding of the very word tells us that commodities are basics goods used in commerce which can be interchanged with other goods of the same type. Things like grains & pulses, gold, oil, natural gas, etc are classic examples of such commodoties.
From an investment point of view, commodity trading is one of the oldest forms of businesses. In the modern age however commodities are just financial instruments which may or may not require physical possession of said assets. You can engage in trading commodities via futures contracts on exhanges. In India commodities are distinguished by their types which are namely- Agricultural commodities, Lifestock and Meat Commodities, Energy, Precious metals, and Industrial metals.
Commodities market unlike the stock market is reliant on basic economic principles such as supply and demand curves. Lower supply on a commodity resulting in higher prices especially on high demand. As the pandemic rolled about there was a significant rise in the trading volumes of Gold, infact gold is the most traded financial instrument arguably because of it’s reliability and high liquidity.
Forex
Forex or Foreign Exhange is the largest financial market globally, accounting for over $4 Trillion in average daily volume. As currency is regulated by a very centralised governmental structure, there is relative stability and the instruments are available to trade round the clock making them ideal to trade regardless of one’s jurisdiction.
This amounts to forex instruments being perfect for short-term day trading on account of it’s high liquidity as well. Apart from that, these stocks come with high levels of volatility that makes it easy for trader to apply short-term price swings.
This however is a fairly more difficult stock to get into for beginners as there’s complex understandings such a spread and optimum return on micro price movements involved, therefore it is reccommended that as a beginner you stick to the other options stated prior.
ETF/Government Bonds
In the end we have some of the most secure financial instruments namely ETFs and Government Treasuries known as bonds. ETFs are investment funds seeking to track the performance of the respective sectoral index, commodities or bonds. ETFs range over a large class of instruments from stocks, bonds, forex, real estate, and commodities.
These options are best suited for long term holdings as preffered method of investment. Government treasuries are some of the best financial instruments given the massive safety cover they inherit. However the caveat in this instance is the fact that with high levels of security comes a slow growth rate which is apparent in the case of government bonds and ETFs.